Month: August 2016

This week, rather than looking at short term trading opportunities, we will examine a longer term strategy that is not dependent on a directional bet for the underlying stock. What it comes down to is positioning. Is this a stock you would be willing to hold longer term, what role will it play in your portfolio (i.e. risk reduction, return enhancement, etc.), what cost is reasonable? Assuming you are comfortable holding the underlying stock and have a rudimentary understanding of the role it will play in your portfolio, options can address acquisition cost.

Covered call writing is a low risk option strategy. If the underlying rises above the strike price the calls are assigned, you deliver the shares and exit with the best case scenario.

Covered calls make money in a rising or flat market and because the premium received reduces the cost of the underlying shares, is less risky than an outright long position in the stock.

Maximum return is at the strike price of the call, maximum risk occurs if the underlying declines to zero. Although to be fair, maximum risk is a function of the underlying security not the strategy.

Now look at naked put writing. Characterizing any strategy as “naked” implies risk. One is not “covered” by a long position in the underlying but rather is taking on a commitment to buy shares at a specific price for a pre-determined time period.

But here’s the rub; If the naked put writer secures the obligation with cash (i.e. cash secured put) is the strategy riskier than covered calls? Maximum return occurs at the strike price, maximum risk if the underlying decline to zero. In short – pardon the pun – covered calls and cash secured puts are equivalent positions.

Options are an invaluable tool when in comes to understanding market sentiment as well as enhancing income and offsetting risk in a portfolio. Watch this video of Richard Croft explaining how we use options and the application of option strategy bands to help in our strategy selection process.